Chapter 28Presentation 2

Government Intervention in Externalities•1. Lawsuits- pay damages to the injured

party or the fear of litigation persuades firms not to pollute

•2. Direct Controls- legislation limiting an activity (fines/imprisonment)

•3. Specific Taxes- levy taxes on causes of negative externalities (ie CFCs)

Subsidy

•A payment of funds (or goods/services) by a government, firm, or household for which it receives no goods/service in return

Government and Positive Externalities •***correcting for under-allocation•1. Subsidies to Buyers- ex discounts for

mothers to get babies vaccinated•2. Subsidies to Producers- $$ given to

doctors or clinics for giving vaccines•3. Government Provisions- provide the

product as a public good (ex Polio Vaccine)

Tragedy of the Commons

•The tendency for commonly owned natural resources to be overused, neglected, or degraded because the common ownership gives nobody an incentive to maintain or improve them

•EX- air, rivers, lakes, street pollution•-dumping toxic wastes instead of proper

disposal

Fallacy of Consumption

•Each firm/individual thinks that their individual contribution to pollution is so small that it is of little or no consequence

•However, multiplied hundreds or thousands of times, this leads to mass pollution

Market for Externality Rights (Cap and Trade)•A market in which firms can buy rights to

discharge pollutants. The price of such rights is determined by the demand for the right to discharge pollutants and a perfectly inelastic supply

•**a pollution control agency determines the amount of pollutants that water/air can safely absorb

Market For Externalities

D2006

D2016S=Supply of

PollutionRights

500 750 1000

$100

$200

P

0 Q

Pri

ce P

er

Poll

uti

on

Rig

ht

Quantity of 1-Ton Pollution Rights

Benefits of Market for Externalities•Monetary reason for firms not to pollute•Conservation groups can buy pollution

rights and not use them•Revenue can be used to fund pollution

control•Increasing costs give incentive for firms

to invest in emissions controls

Asymmetric Information

•A situation where one party to a market transaction has much more information about a product or service than the other

•Buyers and sellers do not have the same information about price, quality or other aspects of a good/service

Moral Hazard Problem

•The possibility that individuals or institutions will change their behavior as the result of a contract or agreement

•Ex- a bank whose deposits are insured against loss may make riskier loans and investments

•-guaranteed contracts for pro athletes•-careless drivers due to insurance

Adverse Selection Problem

•A problem arising when information known to one party to a contract or agreement is not known to the other party, causing the unknowing party to suffer major losses

•EX- the sickest individuals buy the most medical insurance